More on Thrift Conversions

I wrote Thursday about the mutual conversion trade. This is an investment strategy that has worked regardless of who was in the White House, which party controlled the Congress, or what condition the economy was in at the time. The inevitable market dips and declines were merely inventory creation events that allowed investors to buy at sale prices. The conversion process itself creates bargain issues adding capital to an already strong balance sheet. Most of these are smaller local institutions that are extremely well run in the first place, and would be attractive without the extra capital. As the good folks at FJ Capital pointed out, most of them will be taken over in a few years.

The banking crisis has bought mergers to a standstill in all sectors of the banking industry, including conversion. We now have an excess inventory of converted thrifts that are still public and trading at attractive prices. Most of them fit comfortably with my Trade of the Decade strategy of buying banks with high levels of capital, low loan losses and trade below tangible book value.

One such institution is Home Bancorp (HBCP) of Lafayette, La. The bank entered the conversion process in late 2008 just as the credit crisis began to boil over. In spite of this, it has done a great job since that time. HBCP has seen deposit growth for 13 consecutive quarters as consumers favor a relationship with a strong, small bank with local ties. The bank has been able to acquire other banks in the area with FDIC assistance. The organic nonperforming assets ratio is below 2. The total nonperforming loan ratio is above 3, but much of that is acquired loans that have FDIC assistance and guarantees. The stock trades at just 90% of tangible book value and the equity to assets ratio is above 14.

Home Bancorp has been buying back shares and intends to continue doing so. During the third quarter, it bought back 162,629 shares and more than 220,969 shares remain under the current buyback authorization.

The 2007 crop of conversions has already given us several cheap stocks. I currently own shares of ESSA Bancorp (ESSA), First Financial Northwest (FFNW) and Westfield Financial (WFD), all of which engaged in conversion transaction just before the crisis struck. They are all still cheap and have decent fundamentals. First Financial Northwest has had some difficulties with troubled loans and real-estate-owned, but conditions are improving and it has plenty of excess capital. Very few of the 2007 crop have been taken over so far, and I expect this to change over the next few years.

The 2010 crop has given us some solid portfolio holdings as well. I wrote recently about Fox Chase Bancorp (FXCB). I own the shares and have a nice gain in the position. The shares now trade at tangible book value and I would wait for a selloff to add or initiate a position in the stock. I also own Capital Federal Financial (CFFN) and I am up slightly on the position. The bank is in the Midwest and has one of the healthiest loan portfolios in the industry. The equity-to-assets ratio is a little over 20 and it has been using the capital to buy back shares and pay dividends. Neither is exciting or sexy, but I expect to make enormous profits over the next decade as these banks grow or are taken over at large premiums.

The 2011 conversions included one of my favorite little bank stocks, BSB Bancorp (BLMT), a four-branch bank in Massachusetts that has incredibly attractive numbers. The stock trades at just 84% of tangible book value and the equity to assets ratio is above 16. Nonperforming loans are just 0.34% of total assets. Unlike many banks the past few years, BSB is growing. It has seen solid growth in both deposits and loans over the past year. The bank has seen asset growth of more than 22% so far in 2012. Insiders like what they see in the future, and they have been steady buyers of the stock this year.

The thrifts that have converted to stock ownership since 2007 have not seen anywhere near the level of takeover and merger activity experienced in the past. I expect that to change, and conversions will be a source of large profits for those who invest in these safe and cheap financial institutions. Most of them are too small to write about on Real Money, but it will be worth the time and effort to uncover these gems for your portfolio.